THE MARKETS FOR THE FACTORS OF PRODUCTION

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THE MARKETS FOR THE FACTORS OF PRODUCTION

• Chapter 18

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Factors of Production

• Factors of production are the inputs used to
  produce goods and services.

3
The Market for the Factors of Production

• What are the major factors of production?
• What determines how much is paid for each factor
  of production?
• What determines how much of each factor of
  production will be purchased?

4
The Market for the Factors of Production

• The demand for a factor of production is a
  derived demand.

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The Market for the Factors of Production

• The demand for a factor of production is a
  derived demand.
• ä A firms demand for a factor of production
  is derived from its decision to supply a good in
  another market.

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A Firms Demand For Labor

• Labor is the most important factor of production.
• Labor markets, like other markets in the economy,
  are governed by the forces of supply and demand.

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A Firms Demand For Labor
The Market for Apples
The Market for Apple Pickers
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A Firms Demand For Labor

• Most labor services, rather than being final
  goods ready to be enjoyed by consumers, are
  inputs into the production of other goods.

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The CompetitiveProfit-Maximizing Firm

• Two basic assumptions about the firm are
• ä It is competitive in both the product market
  and the input market.
• ä Its goal is to maximize profits.

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The Competitive Profit-Maximizing Firm

• The firm must consider how the size of its
  workforce affects the amount of output that is
  produced.

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The Production Function and The Marginal Product
of Labor

• The production function illustrates the
  relationship between the quantity of inputs used
  and the quantity of output of a good.

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The Production Function and The Marginal Product
of Labor

• The marginal product of labor is the increase in
  the amount of output from an additional unit of
  labor.
• MPL D Q/D L
• MPL (Q2 Q1)/(L2 L1)

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The Production Function and The Marginal Product
of Labor
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The Production Function and The Marginal Product
of Labor
Production
300
function
280
240
180
100
1
2
3
4
5
0
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Diminishing Marginal Product of Labor

• As the number of workers increases, the marginal
  product of labor declines.
• As more and more workers are hired, each
  additional worker contributes less to production
  than the prior one.
• The production function becomes flatter as the
  number of workers rises.

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Diminishing Marginal Product of Labor
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Diminishing Marginal Product of Labor

• This property is called diminishing marginal
  product.

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How many workers to hire?

• To maximize profits, the firm considers how much
  profit each worker would bring in.
• ä Called the value of the marginal product.

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Value of the Marginal Product

• The value of the marginal product is the marginal
  product of the input times the market price of
  the output.
• VMPL MPL X P

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Value of the Marginal Product

• The value of the marginal product is measured in
  dollars.

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Value of the Marginal Product

• It diminishes as the number of workers rises
  because the market price of the good is constant.

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The Production Function and The Marginal Product
of Labor
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Value of the Marginal Product
Value of marginal product
(demand curve for labor)
0
0
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The Hiring Decision

• To maximize profit, the firm hires workers up to
  the point where the value of marginal product of
  labor equals the wage.
• VMPL Wage

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The Hiring Decision

• The value-of-marginal-product curve is the labor
  demand curve for a competitive, profit-maximizing
  firm.

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The Demand for Labor
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The Demand for Labor
0
0
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The Demand for Labor
Value of marginal product
(demand curve for labor)
0
0
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The Demand for Labor
Value of marginal product
(demand curve for labor)
0
0
Profit-maximizing quantity
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Quick Quiz!

• Define marginal product of labor and value of the
  marginal product of labor.

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Quick Quiz!

• Describe how a competitive, profit-maximizing
  firm decides how many workers to hire.

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Labor-Market Equilibrium

• Labor supply and labor demand determine the
  equilibrium wage.
• Shifts in the supply or demand curve for labor
  cause the equilibrium wage to change.

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Labor-Market Equilibrium

• Profit maximization by competitive firms
  demanding labor ensures that the equilibrium wage
  always equals the value of the marginal product
  of labor.

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Labor-Market Equilibrium

• The wage adjusts to balance the supply and demand
  for labor.

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Labor-Market Equilibrium
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Shifts in the Supply and Demand of Labor

• Shift in Supply of Labor
• ä May be caused by a change in the number of
  workers.
• Shift in Demand for Labor
• ä May be caused by a change in the demand for
  the final product produced by labor.

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Shift in Labor Supply

• An increase in the supply of labor
• ä Results in a surplus of labor.
• ä Puts downward pressure on wages.
• ä Makes it profitable for firms to hire more
  workers.
• ä Results in diminishing marginal product.
• ä Lowers the value of the marginal product.
• ä Gives a new equilibrium.

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Shift in Labor Supply
0
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Shift in Labor Supply
Supply, S1
Demand
0
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Shift in Labor Supply
Supply, S1
W1
Demand
0
L1
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Shift in Labor Supply
Supply, S1
S2
W1
Demand
0
L1
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Shift in Labor Supply
Supply, S1
S2
W1
Demand
0
L1
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Shift in Labor Supply
Supply, S1
S2
W1
W2
Demand
0
L1
L2
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Shift in Labor Supply
Supply, S1
S2
W1
W2
Demand
0
L2
L1
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Shift in Labor Supply
Supply, S1
S2
W1
W2
Demand
3. ...and raises employment.
0
L2
L1
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Shift in Labor Demand

• An increase in the demand for labor
• ä Makes it profitable for firms to hire more
  workers.
• ä Puts upward pressure on wages.
• ä Raises the value of the marginal product.
• ä Gives a new equilibrium.

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Shift in Labor Demand
0
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Shift in Labor Demand
Supply
Demand, D1
0
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Shift in Labor Demand
Supply
W1
Demand, D1
0
L1
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Shift in Labor Demand
Supply
W1
D2
Demand, D1
0
L1
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Shift in Labor Demand
Supply
W1
D2
Demand, D1
0
L1
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Shift in Labor Demand
Supply
W2
W1
D2
Demand, D1
0
L1
L2
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Shift in Labor Demand
Supply
W2
W1
D2
Demand, D1
0
L1
L2
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Shift in Labor Demand
Supply
W2
W1
D2
Demand, D1
0
L1
L2
3. ...and increases employment.
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Case Study Productivity and Wages

• What causes productivity and wages to vary so
  much over time and across countries?
• ä Physical Capital When workers work with a
  larger quantity of equipment and structures,
  they produce more.
• ä Human Capital When workers are more
  educated, they produce more.

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Case Study Productivity and Wages

• What causes productivity and wages to vary so
  much over time and across countries?
• ä Technological Knowledge When workers have
  access to more sophisticated technologies, they
  produce more.

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Case Study Productivity and Wages
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Case Study Productivity and Wages
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Quick Quiz!

• How does the immigration of workers affect labor
  supply, labor demand, the marginal product of
  labor, and the equilibrium wage?

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Other Factors of Production Land and Capital

• Capital refers to the stock of equipment and
  structures used for production.
• ä The economys capital represents the
  accumulation of goods produced in the past
  that are being used in the present to produce
  new goods and services.

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Prices of Land and Capital

• The purchase price is what a person pays to own a
  factor of production indefinitely.
• The rental price is what a person pays to use a
  factor of production for a limited period of time.

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The Rental Price and Quantity of Land and Capital

• The rental price of land and the rental price of
  capital are determined by supply and demand.
• ä The firm increases the quantity hired until
  the value of the factors marginal product
  equals the factors price.

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The Rental Price and Quantity of Land and Capital
The Market for Land
The Market for Capital
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The Rental Price and Quantity of Land and Capital

• Land and capital are paid the value of their
  marginal product.
• They each earn the value of their marginal
  contribution to the production process.

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The Purchase Price and Quantity of Land and
Capital

• The equilibrium purchase price of land and
  capital depends on the following
• ä The current value of the marginal product.
• ä The value of the marginal product expected
  to prevail in the future.

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Linkages Among the Factors of Production

• Factors of production are used together.
• ä The marginal product of any one factor
  depends on the quantities of all factors that
  are available.

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Linkages Among the Factors of Production

• A change in the supply of one factor alters the
  equilibrium earnings of all the factors.

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Linkages Among the Factors of Production

• A change in earnings of any factor can be found
  by analyzing the impact of the event on the value
  of the marginal product of that factor.

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Quick Quiz!

• What determines the income of the owners of land
  and capital?

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Quick Quiz!

• How would an increase in the quantity of capital
  affect the incomes of those who already own
  capital?

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Quick Quiz!

• How would it affect the incomes of workers?

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Conclusion

• The three most important factors of production
  are labor, land, and capital.
• Competitive, profit-maximizing firms hire each
  factor up to the point at which the value of the
  marginal product of the factor equals its price.

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Conclusion

• Because factors of production are used together,
  the marginal product of any one factor depends on
  the quantities of all factors that are available.
• As a result, a change in the supply of one factor
  alters the equilibrium earnings of all the
  factors.

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THE MARKETS FOR THE FACTORS OF PRODUCTION

• End of Chapter 18

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Figure 18-1
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Figure 18-2
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Figure 18-3
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Figure 18-5
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Figure 18-6
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Figure 18-7